Street Talk: Patent Issues Could Dominate Pharma Industry in 2006

How much of an impact does patent reform, real or imagined, have on biopharmaceutical stocks?

Plenty. Consider Pfizer as an example.

Brian O'Connell

The pharma giant sent shock waves up and down Wall Street in December '05 when it announced that third-quarter profits had plummeted by 52 percent. That in turn sent company stock down almost nine percent, reaching a 15-year-low.

While declining sales of linchpin drugs like Lipitor and Viagra had a lot to do with Pfizer's financial woes, analysts noted that many investors were jumping ship over the fact that the company has a slew of patents ending their run in 2006. Pfizer will have to battle it out with generic drug makers encroaching on its turf.

Investors spent 2005 nervous about Lipitor's patent, which seemed vulnerable after Ranbaxy Pharmaceuticals filed a patent infringement lawsuit. With $2.9 billion in Lipitor sales, Pfizer had a lot riding on the outcome of this patent case, which ended in Pfizer's favor.

Patent issues place Pfizer at a competitive disadvantage and help explain why so many investors are taking a dim view of the stock in 2006.

"The global pharmaceutical group multiple on 2006 earnings-per-share estimates is currently about 15 times, and Pfizer currently trades at 10.9 times," says Prudential Equity Group analyst Tim Anderson in a December 2005 analyst report.

In short, Pfizer has all the looks of an underperformer in 2006, due largely to worries over patents expiring this year.

Pfizer's patent woes are a big, red flag for the entire prescription drug industry this year. According to Express Scripts, a big pharma benefits manager, more than $38 billion worth of prescription drugs are losing their patent protection in 2006. That's good news for consumers, who will save an estimated $20 billion in drug costs this year (according to Express Scripts), but bad news for drug companies, who will lose that $20 billion in revenues.

Normally, drug prices fall around 20 percent during the first six months in a post- patent protection environment. According to a research report from Gilford Securities, which follows the generic drug market closely, brand name drug companies can expect prices to drop another 20 percent in the subsequent six months. Pfizer can expect to lose $10 billion in revenues due to expired patents over the next two years. A separate report from the Wall Street research firm WR Hambrecht & Company states than an estimated $100 billion worth of name-brand drugs will lose patent exclusivity by 2010.

It's tough to regain those revenues, and investors know that. Says Dr. Steven Miller, as quoted by
http://CNNMoney.com/, drug companies who lose patent protection have to come up with a new idea. That is not easy. "Obviously, they're going to have to discover unique drugs and it probably discourages a lot of investing in me-too drugs," warns Miller. The generic approval gap is squeezing profit margins tighter. According to the US Food & Drug Administration, the FDA has cut generic drug approval cycles from 17 months to 15.7 months.

This is grim news enough for the pharmaceutical industry. But it gets even thornier for drug makers. Generic drug companies are not just settling for quicker response times and larger market share — now they're going after the total patent process, actively and legally challenging patents of major drug companies, including patents that have years to go before they expire.

In a new study by the drug consultant Kline & Company, researchers conclude that generic drug companies are pursuing the patent process to further reduce generic drug approval times. It's a strategy that relies less on sledgehammers than on a hammer and chisel, allowing generic drug companies to chip away at the patent process and slowly bring brand name drug makers to their knees.